The Co-op Under Attack: Reflections from our New York Roundtable

This week I sat down for breakfast with a small group of senior credit professionals in New York. It was the eighth stop in the documentation risk roundtable series, part of the Covenant Exchange initiative. It came after Amsterdam, Los Angeles, Paris, Seoul, Tokyo, Sydney, and Melbourne. New York is the city where the cooperation agreement was born, and it is now the city where the cooperation agreement is starting to come apart.

Up to now, co-op agreements have allowed lenders to build an in-group large enough to resist non-pro rata deals. Now we’re beginning to see what happens when that in-group fragments.

Several recent restructurings have featured the standard pattern but with a twist - a steering committee (which expects to get the best economics), a larger group of general co-op members (signing up so as not to be left behind), and a group of creditors who refuse to join.

This latter group may receive terms better than the standard members because the threat of litigation forces the steering committee to offer enough to make the case go away.

A recent deal showed four distinct tiers of treatment. The original promise of cooperation - that everyone in the in-group gets treated alike - has come apart. This is causing a political problem that’s destroying the co-op from the inside out. When you watch creditors who refused to join the co-op receive better terms than you did, the next time you might not pile in.

The threat of litigation has become leverage in its own right, even if the case never gets filed. When a sponsor is trying to execute an exchange at 95% consent and a sufficiently large group of creditors threatens to sue, the steering committee has a strong incentive to settle.

This isn’t the only threat to co-ops. I’ve written before about how Optimum is putting the question of whether the agreements are anti-competitive before the courts, with facts that are more favorable to the challengers than in Selecta. A finding against the construct in either case could reset the entire framework.

But none of this is a free option. When a borrower files for bankruptcy in spite of the LME, recoveries are reduced and legal fees are spent with no benefit to show for either.

Credit teams now have to decide which path to take long before the situation arises. If you’re not on the steering committee, signing the standard co-op might mean trading certainty for the worst of the eventual terms. Holding out means accepting the litigation risk if the sponsor would rather file than settle. Selling down before the situation develops crystallizes losses but may be the only choice for some lenders - particularly CLOs.

I heard yet again that pushing back on docs has a cost - reduced allocation - that makes engaging with terms in primary a no-win situation. The “negotiation” is starting from looser documents than ever. The agency gap on the primary side is widening at the same time as the holdout story on the secondary side. The two are not unrelated - when primary engagement weakens, the secondary game becomes the only game.

Meanwhile, advisors are pitching solutions to borrowers earlier than ever - and lenders are joining co-ops earlier too. It’s hard to ignore the irony that the documents once designed to protect lenders - to ensure that they receive par back at maturity - have now been weaponized against them, undermining that same promise.